NEW YORK (CNN/Money) -
Surprise! India's reign as the world's "Outsourcing King" may be slipping, even with its rock-bottom call center costs.

A new report from market research firm Gartner, Inc. warns that a labor crunch and rising wages could erode as much as 45 percent of India's market share by 2007.

Indian industry watchers acknowledge that the country's outsourcing industry -- its golden goose of the moment -- is indeed facing a "serious" problem.

In an interview with CNN/Money from New Delhi, Kiran Karnick, president of the National Association of Software and Service companies (NASSCOM), said he's concerned that these challenges could stymie India's strong double-digit growth in outsourcing services.

More importantly, the Gartner report cautions that a host of emerging countries such as the Philippines, Malaysia, Vietnam and Eastern European nations including Hungary and Poland, are also starting to challenge India's leadership in offshore business process outsourcing (BPO.)

Many U.S. and international companies maintain that outsourcing business processes such as customer service call centers, administrative and accounting processes to low-cost and low-wage countries like India helps to keep down their own cost of doing business.

Analysts say India's "go to" status as a premier outsourcing destination is a function of the country's vast pool of about 2.5 million mostly English-speaking graduates that are ready to enter the workforce annually.

But India can't afford to rest on its laurels, said Sujay Chohan, one of the authors of the Gartner report and vice president and research director of offshore business process outsourcing with Gartner in New Delhi.

Unless India devises a long-term roadmap to improve infrastructure and consistently grow its skilled labor force, he said India will see some of its offshore BPO clients shift business elsewhere.

"Although India's infrastructure is improving, it is not keeping pace with the rapid growth of the industry," the report said.

The Gartner report pointed out that while no single nation yet poses a direct threat to India as a high-quality/low-cost location, over the past two years, more than 50 other countries have emerged that together could pose a viable challenge to India in the months ahead.

Gartner estimates that India's current 85 percent ownership of the BPO market share could dwindle to about 45 percent by 2007.

In dollar terms, that would be a significant blow to India, Chohan said. In 2004 India raked in more than $2 billion of an estimated $3 billion global offshore BPO market with more than 250,000 workers.

He estimates that the worldwide offshore BPO market will grow to about $24 billion by 2007 of which India will earn about $13.8 billion.

Rising labor costs

Given that India's been doubling its outsourcing operations every year for the past four years, Chohan said he's not too surprised by the current imbalance in the labor demand-supply equation as well as the onset of wage inflation and high levels of attrition.

"Four years ago, a typical call center employee would have earned between 5,000 to 6,000 rupees ($114- $136) a month. Now it may be up to between 7,000 to 9,000 rupees ($159 - $204) a month," he said. "The rise in labor costs isn't significant yet. What's more important is that these increases so far have not been passed on to clients in the U.S."

But if these costs continue to escalate, he predicts that Indian outsourcing firms will take a hit to their bottom line and eventually start to pass along the increases to their international clients.

Chohan said India could learn from Ireland's mistakes more than a decade earlier.

"This is exactly what happened in Ireland in the 1990s," said Chohan. "As a result, companies that were outsourcing to Ireland began to look elsewhere and discovered India for the lower-level work," adding that Ireland today still attracts what's considered to be "high-value" outsourcing such as R&D and software development.

Chohan isn't worried about India losing it lead in IT outsourcing. "India dominates now and will continue to do so in the future because of the sheer scale of skills in the country at low costs. The only exception is China which has become very visible in this space within the last six months."

Moving beyond call centers

Ashank Desai, chairman of Mumbai-based Mastek, said one way for Indian companies to maintain their competitive advantage and ensure their international clientele is to upgrade their services by offering more sophisticated back office functions in addition to the basic call center services.

Mastek is a provider of offshore IT and BPO outsourcing services. The company logged annual sales of $130 million in 2004.

"At Mastek we're already looking into merging BPO and IT services so that our clients get double the advantage,' Desai said.

He gave an example, "We can reconfigure IT used for processing insurance claims to make it more efficient and then process these claims more efficiently for our customers."

In order to emerge as truly global players and undercut the competition, Chohan said Indian outsourcing companies should also think about expanding their brand globally by setting up delivery centers outside of India.

Indian vendors depend too much on the U.S. market. India has to make inroads into non-English speaking markets as well, "similar to what Ireland has done to successfully service the European market," he said.